Money Mischief_ Episodes in Monetary History - Milton Friedman [10]
Given that it is the real quantity of money, not the nominal quantity, that matters, what determines whether people will want to hold cash balances averaging about five weeks' income—as in practice they have done in many countries over long periods of time—or only about three or four days' income—as they did, for example, in Chile in 1975?*
Two major forces determine how much cash people will want to hold: (1) the usefulness of cash balances as a temporary abode of purchasing power; (2) the cost of holding cash balances.
(1) Usefulness. Cash balances are useful as a means of enabling an individual to separate the act of purchase from the act of sale. In a world without money, transactions would have to take the form of barter. You have A to sell and want to acquire B. To do so you must find someone who has B to sell and wants A and must then make a mutually acceptable deal—what the textbooks dub "the double coincidence of barter." In a money economy, you can sell A for money, or generalized purchasing power, to anyone who wants A and has the purchasing power. You can in turn buy B for money from anyone who has B for sale, regardless of what the seller of B in turn wants to buy. This separation of the act of sale from the act of purchase is the fundamental productive function of money.
A related reason for holding money is as a reserve for future emergencies. Money is only one of many assets that can serve this function, but for some people at some times it may be the preferred asset.
How useful money is for these purposes depends on many factors. For example, in an underdeveloped economy consisting of largely self-sufficient households, each producing mostly for its own consumption, monetary transactions are relatively unimportant. As such societies develop and the range of monetary transactions increases, cash balances rise much faster than income, so that real cash balances, expressed as weeks of income, increase. Such development generally occurs along with urbanization, which has much the same effect, because it means that a larger fraction of transactions are impersonal. Credit at the local grocery store is not likely to be as readily available to smooth over discrepancies between receipts and expenditures.
At the other extreme, in financially advanced and complex societies, such as the United States today, a wide array of assets is available that can serve as more or less convenient temporary abodes of purchasing power. These range from cash in pocket, to deposits in banks transferable by generally accepted check, to money-market funds, credit-card accounts, short-term securities, and so on, in bewildering variety. They reduce the demand for real cash balances narrowly defined, such as currency, but they may increase the demand for real cash balances more broadly defined by making temporary abodes of purchasing power useful in facilitating shifts between various assets and liabilities.*
(2) Cost. Cash balances are an asset and, as such, an alternative to other, kinds of assets, ranging from other nominal assets, such as mortgages, savings accounts, short-term securities, and bonds, to physical assets, such as land, houses, machines, or inventories of goods, which may be owned either directly or indirectly, via equities, or common stocks. Accumulating an asset requires saving, that is, abstaining from consumption. Once the asset is accumulated, it may cost something to maintain, as with physical inventories, or it may yield a return in the form of a flow of income, such as interest on a mortgage or bond or dividends on stock.
As with cash balances, it is important to distinguish between the nominal return on an asset and the real return. For example, if you receive 10 cents per dollar on a bond when prices in general are rising by, say, 6 percent a year, the real yield is only 4 cents per dollar because you must reinvest 6 cents per dollar to have the same purchasing power invested at the end of the year as at the beginning.* The nominal yield is 10 percent, the real yield 4 percent. Similarly, if prices are